Grape Glut

A tax break led to vineyards sprouting everywhere. Now Australia --mon Dieu!--is faced with its own wine lake.

Glen Arnold has been growing grapes in South Australia's Riverland wine region for more than 30 years and says times have never been so tough. This past season a third of his fruit shriveled on the vine because Arnold couldn't find a buyer, not even at a quarter of the usual price. To stunt the growth of the next crop, he may prune his 45 acres of vines severely and limit how much water they get. "I feel devastated," he says. "It's very hard to stay positive."

These should be the best of times for Australia's wine industry. The country's finest wines are snatching trophies away from the French in international competitions. And wine exports have swelled from $305 million in 1995 to $2.1 billion last year, the fourth-highest in the world.

But despite the awards and the export dollars, many of Australia's 2,000 wineries and 8,000 grape growers are facing a French-like crisis: There are far too many vineyards producing far too many grapes, and that's killing profits. Growers in the main wine regions--the Riverina in New South Wales, and Riverland--are being offered as little as $75 a ton, well below the $225 it costs them to produce the fruit. This reality became so frustrating for one grower that he plotted to blow up a winery that was offering him a fraction of what he usually got for his grapes, according to a court hearing in Melbourne last month. So--in emergency meetings--grower associations are urging members to uproot or mothball their vines this winter. In just the Murray Valley, a region in Victoria that typically supplies a quarter of Aussie wine grapes, some 50,000 tons were left to rot on the vine during the 2006 harvest, according to a trade association.

The problems don't end in the vineyard. Using those cheap grapes, wineries are producing a huge surplus, which is shredding prices for bulk and other low-end wine. In fact, the surplus is large enough to serve every man, woman and child in the world a glass on the house. Some wine outfits are taking big writedowns on their inventories. McGuigan Simeon Wines says it might post a loss for fiscal 2006; its market cap has fallen by $300 million in 18 months. Evans & Tate lost $37.5 million in fiscal 2005, and it's valued at a paltry $4.5 million, down from $53 million five years ago.

As often happens in any country when an industry runs into trouble, the grape growers have pleaded with the government for help. But what's surprising is that, in Australia's case, officials have turned them down. The industry wanted a $45 million bailout that would pay growers not to pick some 300,000 tons of grapes in each of the next two years. But the government has been adamant that instead of propping up failing vineyards, it should let market forces decide which ones survive. "Although it does sound mercenary, it's not in our interest to see that everyone survives," says Stephen Strachan, the chief executive of the Winemakers' Federation of Australia.

There's irony in the plea for government help today: The industry can trace its problems to 1993, when winemakers wanted measures to boost the supply of grapes because export demand was growing. Canberra--more eager to intervene than it is today--obliged. It rewrote the depreciation rules so growers could write off the cost of buying and planting vines over just four years, rather than over the lifetime of the vines as with other agricultural assets. What's more, the growers could now take the deductions from the moment the vines were planted, instead of waiting until the first grapes were sold, giving vineyard owners a lucrative shelter for their other income.

It took a few years for growers to gear up, but by the late 1990s vineyards were claiming bigger stretches of the Australian landscape--in some cases with tax-savvy but largely unskilled owners at the helm. In just three years--1997--99--growers planted some 100,000 additional acres, a 40% increase over the 250,000 acres already producing grapes. It had taken 30 years to plant the previous 100,000 acres. By 2000 a grape glut and a wine lake were inevitable with a good harvest.

To be sure, other factors contributed to the frenzy of plantings. In the 1990s, after years of trying to gain acceptance overseas, Australian wines suddenly became the flavor of the month. Exports jumped 36% in 1996. Then the Australian dollar began a long decline, going from 80 U.S. cents in 1996 to 50 cents five years later, which helped export growth--and the demand for grapes--stay high. Grape growers could make extraordinary returns--sometimes surpassing $1,500 a ton for their fruit. With this kind of money to be made, why not start a vineyard?

Even before the deluge of grapes hit the market, there were signs that the party wouldn't last. Chilean, Argentinean and South African vintages were muscling their way onto wine-shop shelves in the U.S. and U.K. Then the Aussie dollar reversed its slide: It's now back to 75 U.S. cents. Export growth suddenly plunged from 28% in 2002 to 6% the next year. For the 12 months through May 2006 exports rose just 1%, according to the Australian Wine & Brandy Corp. And the wine is getting cheaper, as wine lovers can attest: an average of just $2.88 a liter versus $3.59 in 2002. "Once it became evident how many grapes were being planted, it became obvious that we were going to have a challenge on our hands," says Strachan. "For some it's become a crisis."

Australia finally scrapped the tax break in 2004, putting vineyards back on the same footing as other forms of horticulture. "Unfortunately, that tax break was left on for three or four years too long," says Arnold, the Riverland grower. The move, according to Australian Senate documents, came "in response to 'concerns that accelerated depreciation--which drove considerable expansion of the industry over the past decade--could lead to oversupply.'" Could, and did, meaning that growers without long supply contracts with major wineries or beverage companies might be unable to sell next year's harvest, or the year's after that.

For the Australian wine industry, it may all be for the best. The glut of cheap grapes and cheap wine, coupled with the stiffer competition overseas for the mass end of the market, is sending growers and winemakers a message: Move upscale. Indeed, many in the business prefer a smaller, nimbler and more profitable industry based on internationally recognized brands. That would mean more higher-margin premium exports and less of the cheap stuff.

Douglas J. Rathbone is typical of a new wave of Aussie wine entrepreneurs who are focusing on premium wines, such as his Yering Station Reserve line. He owns and operates four wineries, exporting 50% of his premium wine to the U.K. and the U.S., as well as to Hong Kong, Singapore, China and Japan. He still pays his contracted growers $1,100 to $1,400 a ton, a fair price for a premium grape, he says.

Yellow Tail, by contrast, is the entry-level standout of Australia's wine exports, selling in places for $6. But John Casella, managing director of Casella Wines, which produces Yellow Tail, says he's getting squeezed by the growing number of low-end rivals. So the company is turning an eye upmarket. It too would like to have a premium wine for the U.S. market in two years. The price: $40 to $50 a bottle.

The Party's over

Australia is facing tougher competition overseas as the year-on-year growth in the value of its wine exports has declined sharply in recent years.